The Trader

Stocks Shed 1.9% on Week on D.C. Deal Doubts

Dow futures plunge 200% after the close. But a fiscal-cliff deal before the Jan. 1 deadline suddenly doesn't seem impossible. Plus, financial stocks surge, and a way to play the Hispanic consumer market.

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Stocks recorded their worst week since early November, with the Dow falling 158 points Friday on news that Democrats and Republicans were still at odds over a deal to cut the deficit.

Television cameras hovered over the White House late Friday as President Obama huddled with the four top congressional leaders in a last-ditch attempt to stall $500 billion in tax hikes and $110 billion in spending cuts. As word leaked out of the meeting that things weren't going well, stocks plunged, and the cameras panned first over the sad faces in the NYSE trading pit, and then to Nancy Pelosi's forced smile as she left the meeting.

The Street has given politicians the benefit of the doubt in the past few weeks, projecting that they would come to some sort of a deal before the Jan. 1 deadline. Perhaps investors should have seen this coming. In the past two years, Congress has set records for idleness: The House has passed fewer bills during the most recent session of Congress than in any other in more than 60 years — and by a long shot.

For the week, the Dow fell 252.7 points, or 1.9%, to 12,938.1. The Standard & Poor's 500 fell 27.7 points, or 1.9%, to 1,402.4. The Nasdaq dropped 60.7 points, or 2%, to 2,960.3. Both the Dow and S&P 500 have declined for five straight days and are at their lowest closing levels since Nov. 27. On Friday, all 30 Dow components fell, with energy stocks particularly under pressure.

The outlook isn't good for Monday, either. After the market closed, futures trading indicated a scary level of pessimism. Dow futures had shed more than 200 points within half an hour of the close. The folks at Bespoke Investment Group asked if we might have "another 'Lehman Monday' if Sunday night comes and goes with nothing done."

One observer, however, urged reining in the pessimism.

"While you never want to see futures down 200, you need to take it with a grain of salt," said Ryan Larson, the head of equity trading at RBC Global Asset Management. "Keep in mind it's still coming out on Friday afternoon, where volume to begin with was light."

Optimists still abound. Late Friday, President Obama said his talks with leaders were "good and constructive." Indeed, there is a small window open for legislative action. On Sunday, the House of Representatives will reconvene with just a day and a half to go before the deadline passes. Analysts at Standard & Poor's said they don't plan to downgrade the U.S. credit rating again even if the U.S. falls off the fiscal cliff. Starbucks baristas in Washington even started writing "come together" on customers' cups. Thank goodness for small things.

"There's still a serious chance for a deal," said Sean West of the Eurasia Group, which reads the political tea leaves for investors. "The gears are moving. The story line that this was all over three days ago is wrong. We are now going to see real legislative action."

FINANCIAL COMPANIES HAVE had few friends since the credit crisis of 2008-09. But financial shares? That's another matter. With just one trading day left to 2012, financials are the year's best-performing equity sector, up more than 26%. Utilities are the worst, down 3%. That's a neat reversal of their 2011 showing (see table below).

Twelve months ago, after financials had plunged 18% in 2011, few picked them to lead the market rally in 2012. But perhaps too few market seers knew how determined the Federal Reserve was to reflate the U.S. economy and boost consumer spending through continued monetary-policy easing.

The quantitative-easing moves, deleveraging by banks, and a strong housing market and mortgage-refinancing cycle have combined to help banks and other financial stocks, says Jack Ablin, chief investment officer of BMO Private Bank. Bank asset values rose, and banks have improved their balance sheets. That's helped them offset the negative effects of greater regulatory pressure and narrowing net-interest margins.

The Fed's attempts to "unleash the consumer" have been a boon to consumer-discretionary stocks as well, Ablin notes.

The utility sector, 2011's best performer, was hurt in 2012 as many investors grew less risk-averse and moved away from defensive stocks with high dividend yields.

With higher taxes coming in 2013, the consumer is going to have a harder time, Ablin predicts. He thinks consumer-discretionary shares, up 20% in 2012, could drop to the bottom in 2013.

It is hard to see mortgage rates going lower from here, so financials probably won't repeat in first place. And, while utilities might not be last again, with the stocks selling at 14 times earnings, they are relatively expensive given expectations for low earnings growth next year.

If the U.S. is able to resolve its political battle over tax cuts and government spending in a timely manner, the technology, energy, and health-care sectors could outperform in 2013.

Both tech and energy stocks are exposed to stronger growth in emerging markets, and trade at relatively low price/earnings multiples. Health care could also do well because of a combination of stable growth and undemanding valuations.

Choosing the right stocks is the paramount aim, but veteran investors know that stock-picking prowess depends to a large extent on getting the sectors right. Just two stocks in the 31-name utilities sector beat the market in 2012.

-- Vito J. Racanelli

THE 15TH MOST POPULAR SURNAME in the U.S. is Martinez; 1,016,581 American residents answer to it. Every month for the next two decades, 50,000 Hispanics in the U.S. will turn 18. These and similar statistics from the Website Hispanicvoters.com provide a window onto a powerful voting bloc, and a demographic group that more and more companies want to reach.

Ignore this group at your peril. The Republican Party did in November's presidential election, when 71% of Hispanics voted for President Barack Obama. By 2060, Hispanics will account for one of every three people in the U.S., nearly double their 16.7% share of the population now, the U.S. Census Bureau reported recently.

Perhaps no trend is clearer than the importance of Hispanics to advertisers. Spending for ads on Spanish-language TV rose 8% in 2011, while ad-spending on English-language TV fell by 2%.

While both stocks have run up since the election on enthusiasm for their prospects and record political spending, the shares still represent good value. "The prices are reasonable, and the assets are unique," says Haverty. "Political [ad spending] won't happen in 2013, but the demographics of the Hispanic population, and the likely continued importance of TV in reaching this demographic suggest a permanent increase" in the value of the companies' cash flows.

Grupo Televisa trades for $26 a share, or six times its 2013 enterprise value (market value plus net debt) to Ebitda (earnings before interest, taxes, depreciation, and amortization). That compares with EV/Ebitda multiples of eight to nine times for U.S. broadcasters, even though Televisa is a more dominant presence in its core Mexican market than U.S. media companies are in their home markets.

Grupo Televisa's value looks even more attractive in view of its Univision stake. Haverty values Univision at just under $1 billion but sees it rising to $2 billion in the next three years. as advertisers increasingly target the Hispanic market.

Debt-heavy Entravision is a more speculative play. Its stock trades around $1.60, down from $20 or so 10 years ago. It, too, changes hands at about six times EV/Ebitda. Entravision has been enjoying a strong year on higher revenue from political advertising, as well as higher retransmission fees. Many expect the company to refinance its debt in the next year at a much more favorable rate. An encouraging sign: Entravision issued a special dividend last month of 12 cents a share, representing a yield of nearly 9%. Anil Gupta, analyst at Los Angeles-based Imperial Capital, sees the shares rising to $2 within a year as the company posts better growth and outperforms its more expensively valued peer group.

Given Entravision's small size — its market value is only $133 million — Haverty thinks the company and its valuable assets might make a nice fit with, say, Dallas-based
Belo Corp.
(BLC), which owns 20 TV stations and has a market value of $768 million.